Ignore the Raters

By L. Randall Wray

April 18 (NYT)

L. Randall Wray is a professor of economics at the University of Missouri-Kansas City and a senior scholar at the Levy Economics Institute of Bard College. He is the author of“Understanding Modern Money,” and blogs at New Economic Perspectives.

In what appears to be an attempt to influence the political debate in Washington over federal government deficits, Standards & Poor’s rating firm downgraded U.S. debt to negative from stable. Yes, the raters who blessed virtually every toxic waste subprime security they saw with AAA ratings now see problems with sovereign government debt.

The best thing to do is to ignore the raters — as markets usually do when sovereign debt gets downgraded — but this time stock indexes fell, probably because of the uncertain prospects concerning government budgeting. After all, we barely avoided a government shutdown earlier this month, and with S.&P. joining the fray who knows whether the government will continue to pay its bills?

Mind you, this has nothing to do with economics, government solvency or involuntary default. A sovereign government can always make payments as they come due by crediting bank accounts — something recognized by Chairman Ben Bernanke when he said the Fed spends by marking up the size of the reserve accounts of banks.

Similarly Chairman Alan Greenspan said that Social Security can never go broke because government can meet all its obligations by “creating money.”

Instead, sovereign government spending is constrained by budgeting procedure and by Congressionally imposed debt limits. In other words, by self-imposed constraints rather than by market constraints.

Government needs to be concerned about pressures on inflation and the exchange rate should its spending become excessive. And it should avoid “crowding out” private initiative by moving too many resources to our public sector. However, with high unemployment and idle plant and equipment, no one can reasonably argue that these dangers are imminent.

Strangely enough, the ratings agencies recognized long ago that sovereign currency-issuing governments do not really face solvency constraints. A decade ago Moody’s downgraded Japan to Aaa3, generating a sharp reaction from the government. The raters back-tracked and said they were not rating ability to pay, but rather the prospects for inflation and currency depreciation. After 10 more years of running deficits, Japan’s debt-to-gross-domestic-product ratio is 200 percent, it borrows at nearly zero interest rates, it makes every payment that comes due, its yen remains strong and deflation reigns.

While I certainly hope we do not repeat Japan’s economic experience of the past two decades, I think the impact of downgrades by raters of U.S. sovereign debt will have a similar impact here: zip.